A recent private letter ruling released by the IRS, PLR 202113007, reflects the continuing permissibility of certain post-spin-off repurchases of widely held stock. The ruling addresses an added twist: utilizing investment banks to effect the stock repurchases.
Spin-offs and the non-device requirement
Completing a tax-free spin-off provides significant tax advantages. In a spin-off, a parent corporation (Distributing) distributes stock of a subsidiary (Controlled) to its shareholders.
To qualify for tax-free treatment, a spin-off must meet a non-device requirement: the distribution of Controlled’s stock must not be a device for the distribution of corporate earnings and profits (a Device). Numerous other requirements must be met, in addition to the non-Device requirement.1
Regulations set out factors to consider when determining whether or not a spin-off is a Device.2 Private letter rulings provide additional insight regarding the IRS’ views on the non-Device requirement.
Stock repurchases and the non-Device requirement
Post-spin-off sales or exchanges of stock – of either Distributing or Controlled are evidence of Device.3 For example, a spin-off typically would be considered a Device and would not qualify for tax-free treatment if a pre-planned sale to an acquirer of all of the stock of Distributing or Controlled occurred right after the spin-off; the spin-off then would not qualify for tax-free treatment.4
If Distributing or Controlled repurchases its own stock after a spin-off, the repurchases in certain circumstances would be cause the spin-off to be viewed as a Device. A safe harbor for certain open market stock repurchases by widely held corporations was included in Rev. Proc. 96-30, the IRS Revenue Procedure formerly governing private letter ruling procedures.5 This non-Device ruling safe harbor became obsolete in 2003, when the IRS ceased issuing private letter rulings with respect to the non-Device requirement.6
After 2003, the IRS nonetheless did rule favorably on a number of spin-offs involving post-spin-off repurchases of widely held stock.7 Although the IRS did not actually conclude in these private letter rulings whether or not the non-Device requirement was met, the rulings should only have been issued if the IRS did not view the transaction as a Device.
Stock repurchases described in PLR 202113007
In recently released PLR 202113007, Distributing’s planned stock repurchases would not be made on the open market. The IRS held, however, that the repurchases would be treated for purposes of the Non-Device test in the same generally favorable manner as open market purchases. Distributing’s repurchase plan would be executed through investment banks or brokers (Banks). The Banks would borrow shares of Distributing common stock in the public stock loan market and sell them to Distributing. After a “true-up period,” the Banks would deliver additional Distributing shares so that Distributing’s repurchase cost would reach a total pre-agreed amount of cash.
To provide its favorable ruling, the IRS obtained representations about the transaction from Distributing. The representations addressed facts such as: (1) the motivation for the repurchases would be a corporate business purpose and not a desire to increase or decrease the ownership percentage of any particular shareholder(s); (2) the repurchases would apply only to widely held stock and would not exceed 20% of Distributing’s outstanding stock; and (3) the Banks would obtain stock for repurchase only from parties: (i) who are unrelated to Distributing and (ii) whose identities are unknown to distributing.
PLR 202113007 demonstrates that post-spin-off repurchases of widely held stock remain permissible in appropriate circumstances. Distributing’s use of the Banks to effect its stock repurchases was an arrangement that would not have met the old Rev. Proc. 96-30 safe harbor, but was similar enough to arrangements addressed in prior private letter rulings and the old safe harbor for the IRS to view the arrangement with the Banks as equivalent to open market repurchases for purposes of the non-Device requirement. Companies considering a tax-free spin-off transaction should consult closely with their tax advisors.
1These requirements include, but are not limited to: a corporate business purpose requirement, Reg. section 1.355-2(b), a continuity of shareholder interest requirement, Reg. section 1.355-2(c)(1), a control requirement, section 355(a)(1)(A), a distribution requirement, section 355(a)(1)(D), and an active trade or business requirement, sections 355(a)(1)(C), (b)(1), and (b)(2)(A).
2See Reg. section 1.355-2(d), Prop. Reg. section 1.355-2(d).
3See Reg. section 1.355-2(d)(2)(iii).
4See Reg. section 1.355-2(d)(2)(iii)(B); South Tulsa Pathology Laboratory, Inc. v. Comm’r, 118 T.C. 84 (2002).
5Rev. Proc. 96-30, section 4.05(1)(b).
6Rev. Proc. 2003-48.
7See, e.g., PLR 201232014; PLR 200645011.